Currencies

The US dollar has found steadier footing today after trading heavily yesterday. There are two main themes. The first is sterling’s heavy tone. After closing the North American session 0.5% higher yesterday to snap a five-day losing streak, it has come under new pressure today.

The robust US employment report before the weekend allowed the dollar to recoup the losses it experienced earlier in the week against most of the major currencies. The Australian dollar and Japanese yen managed to hold onto minor gains for the week.

The US Dollar Index stalled in front of a band of resistance (96.45-96.55), which houses the 61.8% retracement of the decline from July 27 (97.55) and the 20-day moving average.

This Great Graphic, created on Bloomberg, depicts the Federal Reserve's real broad trade-weighted index of the dollar. Real means that it is adjusted for inflation differentials. Broad means that it covers a wide number of US partners. Trade-weighted means that the countries that the US has more trade with are given greater role in the index.

July was the third consecutive month that this measure of the dollar appreciated and the fourth month of the year.

Our informal and simple model for the Canadian dollar has three variables: oil, interest rates, and general risk environment. Over time, the coefficient of the variables can and do change.

Of the three variables, the general risk environment is the most supportive of the Canadian dollar. Between the BOJ and ECB more than $150 bln a month of central bank, credits are being created. This is one of the key factors driving interest rates down in Europe and Japan.

Our underlying constructive outlook for the US dollar remains intact. It is broadly based on the divergence between the US and most other major economies. The US acted early and aggressively to counter the Great Financial Crisis. Unorthodox policies, such as quantitative easing, were adopted years before the ECB and BOJ. This has produced different outcomes. US economic growth may not be impressive by pre-crisis standards, but it does not seem particularly fragile.

The US dollar is easily the most traded currency, and despite the plethora of other currencies, it is on one side of nearly 90% of all trades. Yet the movement in the foreign exchange market presently is not so much driven by the dollar, as it is other currencies.

With the Bank of England apparently surprising the market more than one might have expected, given the split surveys, many are thinking sterling has bottomed.

If it has bottomed, where could it go? A number of technical considerations suggest toward $1.4200.

Three technical considerations point to that area. The Great Graphic here created on Bloomberg shows the 61.8% retracement of the Brexit fall is found near $1.4170. The 100-day moving average is $1.4195.

Here are two Great Graphics that portray two time series: the dollar-yuan exchange rate and the yuan against a trade-weighted basket. The first chart comes from a highly reputable consulting firm. It replicates the trade-weighted basket that Chinese officials unveiled and shows how it would have performed in the past.

The British pound has been hammered to fresh lows just above $1.3115. The euro is moving toward GBP0.8500. The immediate catalyst is three-fold.

First, one of the UK's largest property funds has moved to prevent retail liquidation. Second, the BOE reversed an earlier decision on the capital buffer for banks, which is tantamount to easing policy by boosting the banks' lending capability by as much as GBP150 bln. Third, UK services PMI was weaker than expected.